Proposed Changes to Pensions and Inheritance Tax: Time to Plan, Not Panic

The world of pensions and investments can be complicated. What exacerbates the problem is that the rules can shift every year, meaning you need to understand each policy change to gauge its impact on your personal circumstances.   

The 2024 Budget announcements will see pensions brought into the inheritance tax (IHT) net from April 2027. The major change has significant implications for how people pass on wealth to their beneficiaries. In fact, for many, the announcement was unsettling. Paying into a pension pot had long been seen as a way to tax efficiently leave a meaningful legacy.  

Understandably, the big shift could cause you concern. However, we would stress the importance of reviewing your estate planning calmly. Policies change regularly, so it’s important not to react impulsively due to fear. In this instance of policy change, there’s still a great deal we haven’t been told, so making premature decisions could actually leave you worse off.   

Here, we break down what’s been proposed and try to work through what’s still unclear. 

Why It’s Time to Plan, Not to Panic 

The Chancellor’s change inevitably means that far more estates could face inheritance tax from 2027.   

That’s not to say though that you need to take action immediately. In fact, reacting too quickly could easily backfire. For instance, withdrawing pension funds now could trigger significant income tax liabilities. Those liabilities could end up being larger than necessary, especially if you are a higher-rate or additional-rate taxpayer. And, once money leaves your pension wrapper, it loses the tax-advantaged environment that helps it grow efficiently.   

Taking a calm, considered approach could prevent any detrimental, adverse effects on your long-term financial plans.  

What’s Being Proposed and Why It Matters 

Today pensions still generally fall outside your estate for IHT. If you pass away before the age of 75, your beneficiaries can drawdown these pension death benefits tax-free. If you pass away after age 75, they will pay income tax on withdrawals, but no IHT.   

Come April 2027, however, the proposed changes to pensions and inheritance tax will stop this from happening. The 2024 budget announcement singled out that:  

• Unspent pension funds passed to beneficiaries will become subject to IHT from April 2027. 
• The standard 40% IHT rate will apply if the inclusion of pension assets pushes the estate above the IHT thresholds. 

 Careful estate planning to remain tax-efficient is therefore more crucial than ever, particularly when you consider that these thresholds have been frozen for several years now, drawing more people into the IHT net. The 2025 Budget confirmed that IHT thresholds will remain frozen until April 2031. For many families, pensions were a crucial part of a strategy to stay below these thresholds. However, now, pensions could change that completely and require a shift in long-term pensions and inheritance tax planning.  

 The key thresholds are: 

•  The nil-rate band of £325,000 
• The residence nil-rate band of £175,000 

What Was Announced in The 2025 Budget? 

Unused pension funds and death benefits will form part of our estate on death. In most cases it doesn’t matter whether the trustees have discretion over their payment – previously a crucial distinction.   

Many will have death in service benefits as part of their employee benefits. These will be excluded from IHT. Death benefits passing to a surviving spouse, civil partner or registered charity will continue to be exempt.   

Personal representatives will be able to direct pension scheme administrators to withhold 50% of taxable benefits for up to 15 months and pay the IHT liability in certain circumstances.  

Why to Avoid Rushed Moves 

Despite the unknowns, wanting to take action is understandable, such as starting to draw down your pension now. However, doing so can easily create more problems such as:  

• Withdrawals may push you into a higher-rate or additional-rate income tax bracket. 
• Money withdrawn from a pension loses its valuable tax-efficient growth potential. 
• Moving assets prematurely can impact the efficacy of your longer-term plan.  

 Each year we read (unfounded) rumours the 25% tax-free cash allowance will be reduced. This year was no exception. Lo and behold this was again unchanged. For those that rushed to take this ahead of the budget with no plan for after, funds that were tax free and now very much taxable. You can’t put the toothpaste back in the tube.  

 Overall, then, sticking to a planned withdrawal strategy may still play a vital part in your IHT planning. While the strategy should be regularly reviewed and amended as needed, this should be made intentionally and with expert advice.  

What You Can Do Now 

There are some steps you can take now that will put you in a good position for when the new rules come into effect.  

1. Model your estate both with and without your pension assets.  
2. Review your intentions for gifting, trusts and other legacy plans to see how they may withstand different outcomes.  
3. Look at other strategies not currently in your long-term plan, which can and may include pension drawdown strategies. Other options could be establishing trusts, life insurance written in trust to cover potential IHT or gifting during your lifetime.  
4. Review the overall mix of the types of assets you hold. 
5. Work with a specialist adviser to help you adapt as the rules become clear and who can stress-test different scenarios for you.  

 We can help with detailed cash flow modelling, estate forecasting and scenario analysis, so you can make fully informed decisions for your financial future.  

Scenario Examples 

If you’re still tempted to start making changes now, these scenarios may emphasise the impact that knee-jerk reactions can make: 

Moderate Pension Posts: Mark has a £280,000 pension and owns a one-bedroom flat. Even with pensions included, his estate may still fall within IHT thresholds. If he panics and withdraws £100,000 now, he pushes himself into a higher income tax band and loses his pension’s tax-efficient growth, despite there likely being no IHT problem to begin with. 

Larger pension holdings: Priya’s £1.2 million pension will likely exceed future IHT limits, but withdrawing £400,000 today would trigger higher-rate income tax and move money into an IHT-exposed environment. Waiting for clarity could allow her to plan around the inheritance tax on pension death benefit 2027 rules, without incurring unnecessary tax costs. 

Married or civil partner couples: Jim wants to withdraw his pension early to avoid future IHT for his children. But if a spousal exemption applies, his pension could pass to Eleanor without IHT first. Acting now could create a large income tax bill they didn’t need to pay, reducing the value of both of their retirement funds.  

What to Watch For in The Final Legislation 

Key details to be mindful of are:   

• Exact definitions and valuation methods 
• Any carve-outs for certain types of pensions or beneficiaries 
• Transitional rules 
• Potential reliefs or exemptions 
• Interaction with broader pension reforms 

 These factors will determine the extent to which the final changes to pensions and inheritance tax will impact you. 

Key Takeaways 

Our overall outlook on the incoming changes to pensions and IHT are that, while they are significant, there isn’t reason to panic. Reacting too quickly could create unnecessary tax costs as well as disrupt what is otherwise a well-structured financial plan. 

Professional financial advice is essential, and we can help you navigate pensions and inheritance tax planning with both clarity and confidence. By staying informed, monitoring government announcements and being ready to adapt, we can help you ensure your long-term strategy remains resilient – whatever the final legislation.   

Speak with one of our Planners to see how potential changes may affect you and discuss the most effective way to update your long-term financial strategy.  

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.